Magazine

A Bonanza Down Under: How Long Can It Last?

February 27, 2005

Like so many other execs eager to profit from China's growth, Charles W. "Chip" Goodyear has become a frequent traveler to Beijing and Shanghai. While others might find themselves impressed by the cities' new skyscrapers and expressways, Goodyear -- CEO of Anglo-Australian mining and energy giant BHP Billiton (BHP) -- likes to ogle the air conditioners jutting from virtually every window. "An air conditioner uses copper, it uses aluminum, it uses steel," and BHP supplies the raw materials for all three, Goodyear notes. With all the air conditioners -- as well as cars, ships, and I-beams -- being made in the mainland these days, BHP's China sales have soared nearly tenfold since 2002, to $2.5 billion last year, and are now 10% of total revenues.

There's no mistaking China's impact on global metals markets. The country's iron ore imports have more than tripled, to 210 million tons, since 2000, according to the International Iron & Steel Institute. In 1996, China accounted for about 10% of the world's demand for aluminum and copper. By 2003 that had doubled, the World Bureau of Metal Statistics shows. "China is pretty much running out of stuff it can pull out of the ground," says Jonathan Anderson, an economist in Hong Kong with UBS (UBS). That means the Australians, who are the primary suppliers of minerals to China, are "going to make out like bandits," he says.

The demand is fueling price increases for commodities -- and explosive growth at Australian resources companies. On Feb. 16, BHP, the world's biggest mining company, announced it had earned $2.8 billion for the six months ended in December, up 110%, on sales of $15.5 billion, up 42%. WMC Resources Ltd. (WMC\), a Melbourne miner of nickel and uranium, reported on Feb. 9 that last year's profits were $1 billion, up 400%, on sales that grew 25%, to $3 billion. And Rio Tinto, BHP's top rival, on Feb. 3 said its 2004 earnings jumped 87%, to $2.8 billion, with sales up 20%, to $14.1 billion. "We have not seen markets like this in nearly 20 years," Rio Tinto CEO R. Leigh Clifford said on Feb. 3.

That means prices paid by steelmakers and other manufacturers are likely to keep rising. Iron ore producers and Japanese steel companies are negotiating contracts for the coming fiscal year, starting on Apr. 1, and all sides expect hefty increases in ore prices. Late last year the likes of Japan's Nippon Steel Corp. and South Korea's Posco (PKX) agreed to pay producers such as BHP and Rio Tinto $125 a ton for coking coal this year -- more than double what they paid in 2004. Those two raw materials alone account for about a third of the cost of steel.

How long can the party last? Guy Elliott, chief financial officer at Rio Tinto, is one of many who believe the good times are far from over. Chinese demand "is sustainable for the medium and long term," he says. Malcolm Southwood, an analyst with Goldman Sachs JBWere (GS) in Melbourne, says this is just the beginning of a major upturn. He compares China's rise to the impact that Japan had on resources in the decades after World War II. Because of postwar reconstruction in Japan and Europe, worldwide steel production grew at 5.2% annually in the '50s and 6.5% in the '60s. Global growth rates sank below 2% in the decades that followed -- but thanks to China, they have surged again to an average of 6.4% since 2001. "We had 20 years [of high growth] with Japan," says Southwood. "China is a lot bigger -- and we have India, Russia, and Brazil waiting in the wings."

Big mining companies are plotting major expansions to cash in on the potential. For instance, BHP says it will spend $10 billion on 14 projects in the works and on feasibility studies for a dozen more. Rio Tinto recently approved a $170 million expansion of an open-pit copper mine in Utah. It's also working on an $870 million copper project in Chile and is spending $685 million on an iron-ore mine in Australia. "We will see new supply to provide for Chinese demand," says Rio Tinto Chief Financial Officer Elliott.

Not everyone is certain that the cycle has the legs to support all that expansion. In the 1990s, some note, resources companies expanded just as new supplies from the former Soviet Union were hitting the market, causing a steep fall in prices and forcing companies into bankruptcy. So some producers are resisting the temptation to make big new investments. "We've seen how bad things can get," says Greig Gailey, CEO of Zinifex Ltd., a Melbourne zinc producer. He knows a thing or two about the perils of over-reaching: He started at Zinifex in 2001 when it was carved out of Pasminco Ltd., a zinc producer that went belly-up after expanding too rapidly.

But analysts credit management at BHP, Rio Tinto, and others for being more disciplined now. "They are being very careful to ensure that expansions aren't big enough to push the market into surplus," Southwood says. And BHP says it spends about five times as much as it did a decade ago on preliminary research before approving new projects. That kind of "front-end loading," CEO Goodyear says, "gives us a huge level of confidence that we know what we're getting into before we make the commitment."

A TOASTER IN EVERY KITCHEN

Some managers are looking to expand their capacity via acquisitions. Cleveland-Cliffs Inc. (CLF), a producer of iron-ore pellets from Ohio, is bidding $465 million for Perth iron-ore miner Portman Ltd. And WMC Resources is the target of a $6.5 billion hostile offer from Xstrata PLC, a Swiss coal trader. Market watchers are waiting for counterbids from BHP or Rio Tinto -- though both declined to comment on the speculation -- or for a WMC joint venture with a partner from North America, China, or even India. WMC says only that it will do what's best for its shareholders. The merger activity and the sky-high prices have helped push stocks to record levels: BHP's Sydney-traded shares are up 33% in the past six months, Rio Tinto's Sydney shares have climbed 21%, Zinifex is up 68%, and Portman's stock has jumped by 85%.

Despite the rosy predictions, companies betting on continued growth in China know they need to pay attention to short-term swings in policy from Beijing. Last spring they had a scare when the Chinese government seemed intent on reining in the runaway economy. But China grew at least 9.5% last year. Still, there's no escaping the business cycle: While prices for many metals are up sharply, some -- including copper, lead, and nickel -- are starting to slow down or even fall a bit. The optimists are hardly fazed. "There's a hell of a way to run until every Chinese kitchen has a stainless steel toaster," says WMC Chief Financial Officer Bruce R. Brook. Be it toasters, air conditioners, cars, container ships, or skyscrapers, it's all good news for Australia's resources companies.